Irwin Michael's specialty is sniffing out undervalued stocks. But after last year's market surge, the manager of ABC Funds has to dig deeper to uncover hidden gems.
"It's becoming tougher and tougher," he says. "A year ago we looked at three stocks to buy one. Now, we look at 10."
The bargains are slim in a market that's already risen 25 per cent, but Mr. Michael and other value investors with proven track records say it's still possible to find them -- if you know what to look for.
That means companies with strong balance sheets and solid business models, but which have been overlooked or beaten down for one reason or another. Maybe the company is in an out-of-favour sector, or its profits have been hammered by short-term factors that obscure the company's favourable long-term outlook.
The trick to value investing is to buy good companies when nobody else wants them, which requires a strong contrarian streak -- and buckets of patience. It is not a game for day traders or investors with weak stomachs.
"With value investing, you want to buy a fairly wide variety of stocks, with the knowledge that . . . from time to time you're going to get a real stinker," warns Norman Rothery, who edits Stingyinvestor.com and the Rothery Report.
For Mr. Michael's part, he looks for companies with price-to-earnings multiples of less than 10 and price-to-cash flow multiples of less than five, and whose shares are trading at a discount to book value.
He searches for hidden assets such as tax-loss carry-forwards or potential spinoffs, and for companies with solid management (although lousy management can also be positive by making the company a takeover candidate).
Among his recent purchases is Sears Canada Inc., which he scooped up for less than book value. The shares closed yesterday at $16.92 on the Toronto Stock Exchange, down from a 52-week high of $21.50 in early November, even as Sears ended the year on a high note with better-then-expected holiday sales.
"I think the stock can go back to the early $20s," he says.
Another retailer he likes is Danier Leather Inc., which has a solid business and no long-term debt, both of which position it nicely for a turnaround in the sector. "The Street loved it at $16 or $17, they hated it at $10, so we bought it at $10, which was book value," he said. It closed yesterday at $11.03.
His ABC Fundamental Value Fund also holds an assortment of paper and forest stocks, including Canfor Corp., which has bounced back since the fall, and still-downtrodden Norske Skog Canada Ltd. The sole bank he owns is Laurentian Bank, which "everyone hates. That's why we feel very comfortable owning it."
Stingyinvestor.com's Mr. Rothery is also a fan of Danier.
"I like the fact that it's cheap, it's growing, it controls its business from top to bottom, it manufactures and sells. I generally think it's a class act," he says.
On the downside, the stock is thinly traded, "so it can get pulled one way or another very quickly."
A more speculative pick is PriceSmart Inc., a U.S.-based operator of warehouse club stores in Latin America, Asia and the Caribbean. If buying at the point of maximum pessimism is your goal, this one has plenty to offer: a share price that has collapsed to $6.32 (U.S.) from more than $40 in 2002, accounting errors, restated financial results, and numerous shareholder lawsuits.
"Given time, this one can turn around nicely, but it is a riskier situation," Mr. Rothery cautions.
When shopping for stocks, value investors often look for a juicy dividend. Riding out periods of volatility is easier if a cheque is arriving every quarter. "Dividends allow us to be stupid longer," jokes Benj Gallander, co-editor of the Contra the Heard investment newsletter.
One dividend-paying stock that made him look smart was Hudson's Bay Co.
He and fellow "Contra Guy" Ben Stadelmann bought it last March at $8.50 (Canadian). The shares are yielding 3 per cent and closed yesterday at $12.15. "We think they've got some awfully good assets and, of course, very well-known name," Mr. Gallander says.
The retailer is also a possible takeover target. South Carolina investor Jerry Zucker has accumulated more than 10 per cent of its shares. Some observers question whether Mr. Zucker will follow through with a bid, but Mr. Gallander wouldn't be surprised.
"In 1997, he bought us out of Dominion Textiles," he says of Mr. Zucker. "He's not just somebody who comes out of the blue, buys a small piece of a company and pumps and dumps. This is somebody who will buy a firm and pay a lot of money for it."
Mr. Gallander bought a handful of stocks in December -- he would not discuss them, citing his newsletter's policy of giving subscribers exclusive access to such information for 30 days -- but bargains aren't in abundant supply.
"I don't see any sectors right now that jump out at me," he says. He and his partner are sitting on "an awful lot of cash" and are in no hurry to spend it. "We won't buy a company that we've followed for less than six months. Often we follow it for more than five years before we will take the plunge," he says. "One of the problems right now is we just don't have that many stocks that are interesting buys."
Richard Howson, chief executive officer of the value-oriented Saxon Mutual Funds family, faces a similar challenge. "It's a lot tougher to find cheap stocks today than it was a year ago, but I believe that there are still cheap stocks out there," says the manager of the Saxon Stock Fund, Saxon Balanced Fund and Saxon High Income Fund.
One he likes is Nu-Gro Corp., which produces packaged fertilizer and other lawn and garden products. The company is trading at less than 12 times earnings and is "statistically cheap," he says.
Another pick is Specialty Foods Group Income Fund. The fund slashed its distribution last fall, citing rising beef prices linked to the discovery of bovine spongiform encephalopathy in Canada.
The units closed yesterday at $7.33, down from more than $10 in September, and are now yielding 8.7 per cent. The setback is only temporary, Mr. Howson says.
"I feel it's a well-run company and I wanted to take advantage of a lower price. You've got to buy these things when things look bleak."
It's not easy to find undervalued stocks in a market that has rallied 25 per cent in the past year. But with a little digging, our experts hope they've hit paydirt with these diamonds in the rough.
Daily Close, SCC-TSX
$16.92, down 5 cents
Daily Close, DL-TSX
$11.03, up 13 cents
Norske Skog Canada
Daily Close, NS-TSX
Daily Close, CFP-TSX
$11.45, up 3 cents
Daily Close, HBC-TSX
$12.15, up 20 cents
Daily Close, LB-TSX
$28.90, down 7 cents
Daily Close, PSMT-Nasdaq, $U.S.
$6.30, down 8 cents
Daily Close, NU-TSX
$8.80, down 20 cents
Specialty Foods Group
Daily Close, HAM, un-TSX
$7.33, up 18 cents
SOURCE: THOMSON DATASTRAM
Only GlobeinvestorGOLD combines the strength of powerful investing tools with the insight of The Globe and Mail.
Discover a wealth of investment information and and exclusive features.